The constitution empowers the Federal Government to collect taxes on income other than agricultural income, taxes on capital value, customs, excise duties and sales taxes. The Central Board of Revenue (CBR) and its subordinate departments administer the tax system. Each of the three principal taxes has a different history and different set of issues. For a large number of income tax payers the core of the business process is pre-audit and assessment by a tax official. This process gives considerable discretion to tax officials, with potential for abuse.
Moreover, this process is also not tenable as the number of taxpayers increase. The report is focused on a total overhaul of the process and organization of income tax. Sales tax is recent and its process and organization is adjusted to the needs of an expanding tax base. These are based on self-assessment and selective audit. Similarly, in customs the accent is on accelerating and broadening the changes begun in recent years. Before long, central excise will be subsumed in sales tax.
During the nineties, despite many changes in the tax regime and introduction of withholding and presumptive taxes, Federal Government tax to GDP ratio has varied narrowly around eleven percent. The tax base has grown but still remains narrow and skewed. The number of income tax filers is around one million. At less than one per cent of the population, it is a lower proportion than in many developing countries. Pakistan’s fiscal crisis is deep and cannot be easily resolved. Taxes are insufficient for debt service and defense. If the tax to GDP ratio does not increase significantly, Pakistan cannot be governed effectively, essential public services cannot be delivered and high inflation is inevitable.
The Reforms to improve our taxation system need to be focused on human resources, business process and organization, corruption and information management. An effective revenue organization must be comprised of trained and dedicated persons with integrity, transparent processes, a comprehensive information system, and taxpayer education. The paper recommends self-assessment, selective audit, and expansion and upgrading of information management, emphasizes reduction of discretion and direct contact between tax collector and taxpayer How to calculate income tax in Pakistan.
Law concerning taxation of income in Pakistan is stated in the Income Tax Ordinance, 2001 (the Ordinance) and the rules framed thereunder viz. Income Tax Rules, 2002 (the Rules). The Ordinance is a Central statute and is, therefore, applicable to the whole of Pakistan . Under section 4 of the Ordinance, income tax is imposed for each tax year at specified rates on every person who has taxable income for the year. The tax payable is calculated by applying the rate(s) of tax to the taxable income of the taxpayer for the year and any tax credit allowed to the taxpayer for that year is deducted from that amount.
. The following tax credits are allowed under Chapter 3 Part 10 of the Ordinance: Charitable donations, investment in shares, retirement annuity scheme and profit on debt. Tax year in Pakistan Tax year is a period of 12 months ending on 30th June and shall be denoted by the calendar year in which the said date falls Taxable income in Pakistan It is the total income of a person for a tax year reduced by the total of any deductable allowances, under the Ordinance for the year. A person is entitled to deductible allowance for the amount of any Zakat paid by the person in a tax year under the Zakat abd Ushr Ordinance, 1980.
Total income It is the sum of a person’s income under each heads for income for the year. Heads of Income in Pakistan Under the Ordinance income is classified under the five heads: Salary, income from property, income from business, capital gains and income from other sources The income of a person under a head of income shall be the total of the amount derived by the person in a tax year that are chargeable to tax under the head as reduced by the total deductions allowed under the ordinance to the person under that head. Capital value tax in Pakistan.
CVT is payable by individuals, firms and companies which acquire an asset by purchase or a right to use for more than 20 years. It is also payable on import of motor vehicles. Workers Welfare fund in Pakistan WWF is levied at 2 % of a company’s income exceeding Rs. 200000 Corporate Asset Tax in Pakistan Levied through the section 12 of the finance Act, 1991 it is one time levy payable by a company on the value of fixed assets held by the company on the specified dates PAKISTAN’S TAXATION SYSTEM Federal taxes in Pakistan like most of the taxation systems in the world are classified into two broad categories, viz., direct and indirect taxes.
A broad description regarding the nature of administration of these taxes is explained below: Direct Taxes Direct taxes primarily comprise income tax, along with supplementary role of wealth tax. For the purpose of the charge of tax and the computation of total income, all income is classified under the following heads: • Salaries • Interest on securities; • Income from property; • Income from business or professions • Capital gains; and • Income from other sources. Personal Tax All individuals, unregistered firms, associations of persons, etc., are liable to tax, at the rates rending from 10 to 35 per cent.
Tax on Companies All public companies (other than banking companies) incorporated in Pakistan are assessed for tax at corporate rate of 39%. However, the effective rate is likely to differ on account of allowances and exemptions related to industry, location, exports, etc. Inter-Corporate Dividend Tax Tax on the dividends received by a public company from a Pakistan company is payable at the rate of 5% and at the rate of 15% in case dividends are received by a foreign company.
Inetr-corporate dividends declared or distributed by power generation companies is subject to reduced rate of tax i. e. , 7. 5%. Other companies are taxed at the rate of 20%. Dividends paid to all non-company shareholders by the companies are subject to with holding tax of 10% which is treated as a full and final discharge of tax liability in respect of this source of income. Treatment of Dividend Income:
Dividend income received as below enjoys tax exemption, provided it does not exceed Rs. 10,000/-.• Dividend received by non-resident from the state enterprises Mutual Fund set by the Investment Corporation of Pakistan. • Dividends received from a domestic company out of income earned abroad provided it is engaged abroad exclusively in rendering technical services in accordance with an agreement approved by the Central Board of Revenue. Unilateral Relief: A person resident in Pakistan is entitled to a relief in tax on any income earned abroad, if such income has already beensubjected to tax outside Pakistan.
Proportionate relief is allowed on such income at an average rate of tax in Pakistan or abroad, whichever is lower. Agreement for avoidance of double taxation: The Government of Pakistan has so far signed agreements to avoid double taxation with 39 countries including almost all the developed countries of the world. These agreements lay down the ceilings on tax rates applicable to different types of income arising in Pakistan. They also lay down some basic principles of taxation which cannot be modified unilaterally. Customs.
Goods imported and exported from Pakistan are liable to rates of Customs duties as prescribed in Pakistan Customs Tariff. Customs duties in the form of import duties and export duties constitute about 37% of the total tax receipts. The rate structure of customs duty is determined by a large number of socio-economic factors. However, the general scheme envisages higher rates on luxury items as well as on less essential goods. The import tariff has been given an industrial bias by keeping the duties on industrial plants and machinery and raw material lower than those on consumer goods.
Central Excise Central Excise duties are leviable on a limited number of goods produced or manufactured, and services provided or rendered in Pakistan. On most of the items Central Excise duty is charged on the basis of value or retail price. Some items are, however, chargeable to duty on the basis of weight or quantity. Classification of goods is done in accordance with the Harmonized Commodity Description and Coding system which is being used all over the world. All exports are exempted from Central Excise Duty. Sales Tax
Sales Tax is levied at various stages of economic activity at the rate of 15 per cent on: • All goods imported into Pakistan, payable by the importers; • All supplies made in Pakistan by a registered person in the course of furtherance of any business carried on by him; • There is an in-built system of input tax adjustment and a registered person can make adjustment of tax paid at earlier stages against • The tax payable by him on his supplies. Thus the tax paid at any stage does not exceed 15% of the total sales price of the supplies; ANALYSIS OF EXISTING TAXATION SYSTEM Income Tax.
In the last decade income tax, together with sales tax, has become the principal source of revenue for the federal government. Its contribution to total tax revenue stands at 28 percent, and its share in GDP has increased from less than 2 percent of GDP in the early 1990s to 3. 6 percent of GDP by the end of the decade. The inflation adjusted annual increase in income tax revenue was 10. 7 percent between 1990-91 and 1999-2000, which compares with the real increase in non-agricultural GDP of 4. 2 percent. 1 The revenue is raised at a cost that amounts to less than 1 percent of the revenue collected.
2 Despite these reassuring statistics, there is widespread disaffection with the functioning of the income tax department and its performance. There are several factors that have resulted in this state of affairs. Some of these are rooted in the income tax legislation, others are an outcome of the constitutional structure of the country, others are the result of a complex web of lobbying and political compromises, and still others are dictated by the revenue crunch that is faced by the country. The number of active tax-filers in Pakistan is about 1. 05 million, which is 0. 07 percent of the population.
The number of persons in the registers of the income tax department is about 2. 0 million, out of which about 1. 2 million have been assigned national tax numbers. The percent of population on national tax register is 1. 4 percent of the population which compares with 2. 2 percent in India, 13. 6 percent in Argentina, 53 percent in France and 82. 5 percent in Canada. The cross-country comparison is usually not very useful because of considerable differences in ‘the economic structures, tax laws and administrative procedures’. Among tax filers the number of companies was 18,000 in 1997, which paid 53 percent of the total tax revenue.
The salaried taxpayers, who numbered 410,000, contributed about 7 percent of the total revenue. The number of taxpayers who filed under the self-assessment scheme was 359,000. 3 In any given year only a very small percentage of salaried taxpayers are assessed for income tax purposes, as is the case of taxpayers who qualify under self-assessment scheme. Effectively only about 250,000 or 25 percent of tax-filers are subject to any degree of tax assessment. This includes all company cases, which are subject to 100 percent tax audit unless the entire income of a company is subject to presumptive tax.
These taxpayers are not chosen on the basis of their risk profile nor because there is a prima facie inconsistency in their accounts but because these are the residual group once the salaried persons and self-assessment group are effectively excluded for detailed audit. The 250,000 audits/assessments are handled by an officer cadre in grade 16-18, who number about 650. This means a workload of about 400 audits/assessments per officer per year. Therefore, it is not surprising that an overwhelming number of tax audits are conducted in haste and are perfunctory.
For income tax purposes, the population of the country could be categorised as: (1) cases with no incomes or whose incomes are below the income tax threshold, (2) cases which fall within the taxable bracket but are exempt from payment of income tax under Schedule II of ITO, 1979, (3) cases which fall within the taxable bracket but have successfully avoided entering the tax net, (4) cases which are within the tax net but under-report their incomes, (5) cases which are within the tax net and correctly report their incomes but where there is the possibility of differences with the tax department on the extent of their taxable income.
A measure of the extent of tax evasion is provided by the value of assets declared under the recent tax amnesty scheme. Under this scheme, assets of Rs120 billion were declared, which could not be explained through known income sources. A tax at the rate of 10 percent on these assets raised Rs12 billion in revenues. Assuming that 10 percent was a low tax rate and that under normal course of events a marginal tax rate of 20 percent would have applied, the extent of tax evasion could be taken as Rs24 billion.
If these assets had been created within the last 10 years, the annual tax evasion would amount to Rs2. 4 billion. This is about 2. 27 percent of the income tax revenue raised in 1999-2000. While property and commercial surveys, if conducted frequently can identify individuals and businesses that are outside the tax net and also limit the scope of tax evasion, these do not address one important source of tax leakage, namely ‘flight of capital’. If tax that is evaded and reinvested back in the form of domestic assets is easily detected throughsurveys, tax evaders could start investing in foreign assets.
The extent of this leakage may already be significant and could gain momentum if local avenues of evading taxes are effectively plugged. This is a strong case for detecting evasion primarily through effective tax audit and supplementing it with regular surveys to identify non-filers and cases of under-declaration and false declaration. If tax evasion is detected at the audit stage, than it can be caught before it finds its way out of the country. The reforms I am suggesting focus on tax administration and tax processes.
A good tax system requires a good tax policy but more importantly, an administrative system that can put these policies into practice. Tax reform efforts in the past have concentrated primarily on issues of policy; the issue of improvement of tax administration and of processes has not been given the importance it deserved. The core subject of this reform effort is the improvement in tax administrative structure and simplification of processes. We begin by looking at the organisational structure of the tax department. Sales Tax The sale tax is evolving into Pakistan’s key revenue earner is beyond any doubt.
What is even more impressive is the growth of sales tax revenue during the latter half of the nineties. During this period, real sales tax growth was 2. 9% per annum faster than the growth of direct taxes, a true testimony to its buoyancy. Although the performance of the sales tax has been impressive, it still remains short of the potential achieved by high performing developing countries, where its contribution to the GDP ranges between 4% and 9%4. The Proposed Reforms shall be driven by four broad objectives: • To increase the long-term revenue generation capacity of the administration?
To lower compliance costs of taxpayers through process reform • To reduce the misuse of discretion by reducing the points of contact between the taxpayers and the tax officials. • To create an impartial and judicious adjudication system, which gives relief when faced with excesses Customs Pakistan Customs is one of the oldest organisations of the Federal Government. Customs regulatory framework was first consolidated under the Sea Customs Act 1878. Over the years, as international trade grew, Customs administration gained importance, both as a major source of federal tax revenues and as a regulator of the economy.
Nevertheless, the Customs administration and its regulatory framework did not fully keep pace with the developments in international trade and the requirements of domestic economy. The Sea Customs Act, 1878 was replaced by the Customs Act, 1969, but it did not contain any substantial changes. Pakistan was one of the first few developing countries to join the Customs Cooperation Council (now called World Customs Organisation) and adopt the internationally applied classification system (then referred to as Customs Cooperation Councils Nomenclature).
However, Customs procedures, in general, did not keep pace with the changing requirements of international trade. The customs operations initially revolved around imports by sea and were codified and published in a document called Appraising Manual. It contained operating procedures, which envisaged 100% scrutiny of import and export documents and examination of all goods, imported or exported. This document spelt out standard operating procedures (SOPs) for various Customs tasks. With the passage of time, the use of this document as a reference guide diminished; now it is hardly available.
Essentially, Customs procedures are based on a manual system with multiple checks and verifications of every transaction, hallmarks of a defensive and time-consuming system. These procedures were devised at a time when the volume of international trade and the number of import and export transactions were small and import tariffs were prohibitively high. The analysis of Customs business processes highlights that they involve numerous steps, handling officials, signatures and verifications, and are cumbersome and irritating.
A summary of the basic characteristics of Customs business processes is presented below: • The existing business processes of Customs are fundamentally manual, devised to handle a small volume of transactions. Besides being tedious and time consuming the lend themselves to collusive malpractice. • Clearing agents carry documents from desk to desk for completing various steps in each process. They move with documents from one official to the next, as they follow the process. • Existing work methods and processes allow excessive interfacing between Customs employees and clearing agents/clients.
The clearing agent has become an integral part of the processes. • A large number of Customs officials are involved in completion of business processes and various steps, verifications and signatures for completing processes are rather large. • The client has to travel considerable distance to complete formalities as Customs offices are awkwardly and distantly located. ? There are a number of unnecessary steps which involve office support staff and sepoys for recording the movement of documents and affixing stamps. This results in further interfacing and delays.
• There are no time standards for the completion of various activities/sub-processes. There is no effective monitoring system in place to check delays on part of the Customs employees. • In the absence of universally applicable operating procedures and weak post-audit function, there are ample opportunities to misuse discretion by officials at functional levels. This is particularly true in determination of values for duties and application of exemption notifications. • At present there is no negative profiling system for maintaining record of high-risk clients for targeted enforcement measures.
However, a positive system of profiling for various categories of exporters and for sanctioning duty drawback claims has been introduced. • The dispute resolution system is slow and cumbersome. Stakeholders are generally dissatisfied with the existing system to redress genuine grievances arising out of the arbitrary exercise of authority and delays in decision-making, which adds to their financial costs. • Customs administration handles an ever-increasing volume of international trade with a tall hierarchy. Superimposed on the operational level is a top-heavy supervisory tier.
The documents have to pass through several layers of officials before a single transaction is finalised. • There is a preponderance of inappropriately qualified non-functional support staff vis-a-vis operational level officers. Presence of such a large number of non-operational staff adds negative value to business processes. • Quality of clearing agents, responsible for making important professional input to the business processes, is generally poor due to weak system of issuance and renewal of licenses to the clearing agents.
• Officials of the rank of sepoys perform critical functions of escorting bonded warehouse goods and similar other functions. Likewise, the office support staff (Lower Division Clerks and Upper Division Clerks) is involved in the custody of documents/files involving large amounts of revenues in the shape of bank guarantees. This may lead to manipulation of documents/records with substantial financial risks. • There is no uniformity in business processes on countrywide basis. Most of the inland Customs stations follow business procedures specific to their local settings.